To calculate depreciation expense using the straight-line method, three key variables are essential: cost, useful life, and residual value. The formula for determining the depreciation expense per period is:
Depreciation Expense = \frac{Cost - Residual Value}{Useful Life}
In this formula, Cost refers to the initial purchase price of the asset, Residual Value is the estimated value at the end of its useful life, and Useful Life is the duration over which the asset is expected to be used, typically measured in years. The difference between the cost and the residual value is known as the depreciable base, which represents the total amount that will be depreciated over the asset's useful life.
For example, consider a delivery truck purchased for $42,000 with an estimated useful life of 5 years and a residual value of $2,000. To find the annual depreciation expense, we first calculate the depreciable base:
Depreciable Base = Cost - Residual Value = 42,000 - 2,000 = 40,000
Next, we divide the depreciable base by the useful life:
Depreciation Expense per Year = \frac{40,000}{5} = 8,000
This means that each year, the company will record a depreciation expense of $8,000. The journal entry to record this depreciation expense involves debiting the depreciation expense account and crediting the accumulated depreciation account:
Debit: Depreciation Expense $8,000
Credit: Accumulated Depreciation $8,000
Accumulated depreciation is a contra asset account that reduces the net book value of the asset on the balance sheet. To calculate the net book value after one year, we subtract the accumulated depreciation from the cost of the asset:
Net Book Value = Cost - Accumulated Depreciation = 42,000 - 8,000 = 34,000
On the balance sheet, the asset would be listed at its historical cost, with a line item for accumulated depreciation to reflect its reduced value:
Truck: $42,000
Less: Accumulated Depreciation: $8,000
Net Book Value: $34,000
This presentation ensures that the financial statements accurately reflect the asset's value over time, accounting for the wear and tear as it is used in operations.
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